Low Interest Rates Mean Higher Valuations

Low Interest Rates Mean Higher Valuations

There is almost no debate that a good portion of the last few months’ stock and bond market reflation has been due to the money pumped into the financial system by governments post-Covid, as well as the oil market collapse. What has been lost in this story is the fact that, contemporaneously, central banks around the globe reduced interest rates to zero. It also appears that interest rates will stay at zero for a good while—and barring a change in the macro environment, rates will stay in a low range for the next five to 10 years. Zero to low rates have great influence regarding the valuations of assets and businesses.

Streams of income that have durability to them will be even more valuable when markets recover, as low interest rates make cash flows from investments such as alternatives even more compelling. Even recently, institutional and retail savers were able to earn ±2% in government bonds, but with all government debt now paying a nil return. Thus, the alternatives of real estate, infrastructure, renewables, private equity and private credit have become even more compelling. It is very likely that long-let property, contracted or regulated infrastructure, long-leased renewables and private credit assets will have higher valuations a year from now than they did a year ago.

As an example, someone who owns an office building that is fully leased to good-quality tenants with rents locked in for the longer term, generating $50 million of cash flow pre-Covid, could take on and service about $700 million of 4% debt and have $22 million cash flow left over for the equity owners. With interest rates dropping, that mortgage is now at approximately 2.25%, meaning the cash flows to the equity have become ±$35 million. The value of the equity on this property was ±$600 million pre-Covid—and today it’s likely ±$1 billion.

A second example concerns the value of an operating business with stable cash flows. Westinghouse, a company we own, provides engineering and technology services to owners of nuclear power plants. It has had extremely stable revenues through the last six months, and we expect that to continue in the future. The EBITDA was $600 million pre-Covid (and still produces that), and at a 10 times multiple of cash flow, that business was valued at $6 billion last year. With approximately $3 billion of debt, the equity was approximately $3 billion. Now, with the world searching for returns and this business having proven its resilience, a multiple of 12 to 15 times is potentially more reasonable. If so, the equity of the business is now approximately $4 to $6 billion, suggesting an increase of upwards of $3 billion over its value at the start of this year.

Of course, the above does not apply for assets where the cash flows are uncertain. Although it is also very possible that many of these assets will also receive higher multiples, it may take time for investors to gain confidence in those income streams so that they can be awarded.

Bruce Flatt

Chief Executive Officer

Brookfield Asset Management Inc.

August 13, 2020